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Distortionary Taxes and Public Investment in a Model of Endogenous Investment Specific Technological Change

Bishnu, Monisankar and Ghate, Chetan and Gopalakrishnan, Pawan (2011): Distortionary Taxes and Public Investment in a Model of Endogenous Investment Specific Technological Change.

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Abstract

We construct a model of endogenous growth in which public capital financed by distortionary taxes influences investment specific technological change. Our main result is that there exist infinitely many capital and labor tax-subsidy combinations that decentralize the planner's growth rate. Hence the optimal factor income tax mix is indeterminate which gives the planner the flexibility to choose policy rules from an infinitely large set. Accounting for administrative costs, however, reduces the set of optimal feasible tax mix of the planner. The size of this set shrinks as the convexity of the administrative costs increases, and eventually a unique factor income tax mix emerges as the only feasible solution. A numerical exercise shows that the growth effects of factor income tax changes are not large.

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